Cross-border mergers and acquisitions – Charting the regulatory landscape
Cross-border mergers and acquisitions – Charting the regulatory landscape
In the latest issue of Into Africa, Corporate & Commercial Director and Head of CDH's Africa practice, Deepa Vallabh, and Corporate & Commercial Associate Motheo Mfikoe point out that the growth of African markets in the recent years has occurred through cross-border M&A activity, and has become an important source of FDI.
Currently, the continent is experiencing a growth of the middle class and the private sector which in turn have an increased influence on the economy and the implementation of structural and economic regulatory reforms. This article deals with the challenges of investing in Africa and what is required in order to establish an effective regulatory landscape which would facilitate unlocking this growth potential.
Despite the fragile and slow economic growth in many developing countries, the growth of African markets in the recent years has occurred through cross-border M&A activity, and has become an important source of foreign direct investment ("FDI"). Between 2010 and 2015, 5000 individual FDI deals in Africa were identified by McKinsey Global Institute, in terms of which the deals were primarily produced by multinational companies operating in Africa with a pan-African footprint. Asia has become an important source of cross-border M&A activity in Africa. The investment interests from China, India and Japan are expected to lead to increased M&A activity in Africa. The continent is on an upward trajectory in terms of the volume of M&A deals, with cross-border transactions accounting for 36% of the total M&A volume in 2016, however deal value shows a downward trajectory.
The lack of regulatory certainty or stringent regulatory barriers are known to be one of the biggest threats for M&A transactions in Africa. Merger control, exchange control and sector specific regulations are intrinsic to every M&A transaction and can affect the success or failure of the proposed transaction. For that reason, due diligence investigations are an important part of the M&A process. The due diligence investigation provides information, including but not limited, to the regulatory framework of the country in which the transaction is proposed, the political and economic environment, infrastructure, the cultural aspects of the jurisdiction and the tax and labour issues that may arise. Further the investigation allows for early mitigation of any risks uncovered in the target company and its jurisdiction.
South Africa and Nigeria are examples of how the volatility of financial markets in host countries affect the deal value. The currency instability and insufficient financial recourse against the seller also creates a hindrance to investor confidence. In Nigeria, the Central Bank of Nigeria has implemented policies to increase control over the foreign exchange and these policies, together with a substantially low supply of foreign exchange has led to the devaluation of Nigeria's currency. Similar to Nigeria, Algeria contains a high fiscal budget deficit and like Angola, comprises of higher reliance on the oil production. As a result, the drop in global oil prices has created downward pressure on their currencies. Consequently, the combination of conservative prospects for financial and economic performance and increased risk built into the costs of capital has taken a toll on valuations and as a result on the transaction values of potential deals.
African states can increase investor confidence by implementing exchange control policies in order to restrict the amount of foreign currency or local currency that can be traded and as a result allowing countries a greater degree of economic stability by limiting the amount of rate instability due to currency inflows and outflows. However, caution must be exercised where exchange rate policies result in a further depreciation of currency such as in Nigeria where the non-market derived exchange rate has devalued its currency. Further, African states must focus on having economic reforms improving fiscal policies that make it easier for investors to invest and transact in Africa. Morocco and Egypt have shown an increase in the volume of the deals. Egypt has done so by causing deep cuts to fuel subsidies to reduce its budget deficit and Morocco adopted a new banking law which aims to create a financial and economic crossroad between Africa and the rest of the world.
Africa has an additional difficulty of establishing competition law which aligns with each countries national competition laws. Despite the challenges, common economic links between states makes it ideal to operate a regional competition authority. In East Africa, the East African Community Council of Ministers adopted the East African Community Competition Authority (“EACCA”), which is the competition authority over Burundi, Kenya, Rwanda, Tanzania and Uganda. The EACCA has jurisdiction over all M&A transactions and enforcement matters with cross-border competition effects in terms of the East African Community Competition Act, 2006. However, there has been challenges in aligning the approach of both the national regulators and that of the EACCA. Timing of these approvals are also problematic as they may delay deal implementation.
The Common Market for Eastern and Southern Africa (“COMESA”) established the COMESA Competition Regulations and Competition Rules, regulated by the COMESA Competition Commission ("CCC") for 19 countries within Africa, in terms of which it is to ensure the efficient operation of markets with the view of enhancing free and liberalised trade as a pre-requisite to safeguarding the welfare of customers. These regulations and rules apply only in instances where a transaction has a cross-border impact and therefore does not repeal national competition laws. As mentioned before, this creates another layer of difficulty for investors wishing to invest in Africa as regional frameworks such as the CCC and the EACCA are an additional layer of regulation over national legislation.
The political environment of a country creates additional challenges to investing in Africa. These challenges include issues such as a change in regime, social unrest such as the terrorist attacks by Boko Haram in Nigeria and central Africa or South Africa's political instability under the Jacob Zuma administration resulting in two credit ratings downgrade or the states intervention in business affairs such as the expropriation of land laws in Zimbabwe, which had a significant effect on its agricultural sector. Political and security risks, coupled with high unemployment also remain key issues that need to be urgently addressed to unlock growth.
The complexity of certain sectors creates an abundance of laws and regulatory roadblocks which creates an additional challenge for investors. Sectors such as the banking, telecommunications, insurance, oil and gas and mining sectors are overregulated as they have additional sector specific legislation in additional to applicable national legislation and in some cases, regional regulations which are triggered when cross-border transactions are concluded. An example of this would be the failed transaction of Nigeria's Code Division Multiple Access and an American investment group, CAPCOM Limited in terms of which slow regulatory interventions from both the Securities and Exchange Commission and the Nigerian Communications Commission served as a hindrance to the transaction. Moreover, many sectors in Africa contain an uncertainty of the regulatory framework, such as in the oil and gas sector whereby countries such as South Africa, Democratic Republic of Congo and Tanzania are still uncertain as to the revision and development of their energy regulation and policies.
Bribery, corruption and an unfamiliar litigation culture, are additional challenges for M&A activity in Africa. This is particularly high in natural resources projects where international companies find themselves under pressure to bid for concessions with or award contracts to local companies linked to top government officials. These factors accompanied by the inadequacy of infrastructure, lack of sophistication surrounding risk management, unfamiliarity with corporate governance and financial reporting requirements and unknown environmental liabilities creates further challenges to transacting in Africa.
However, despite the regulatory challenges, the growing population and expanding middle class coupled with new consumption patterns, should stimulate growth in sectors such as the financial services, consumer goods, retail, healthcare and transportation services. In 2015, M&A transactions in Kenya’s retail industry increased with supermarket chains such as Na-Kumatt having 52 stores in East Africa. In the banking and finance sector, Kenyan banks Kenya Commercial Bank, Equity Bank, Fina Bank and Commercial Bank of Africa have 16 branches in Tanzania, 31 branches in Uganda and 16 branches in Rwanda. In the telecoms sector, MTN Uganda and Safaricom concluded an agreement in terms of which Safaricom mobile money users were allowed to transfer money into MTN mobile money accounts in Uganda and Orange Group exited all its East African operations by selling 70% ownership in Telkom Kenya to Helios and its operations in Uganda to Africell.
Understanding the nuances of the target company's regulatory framework is necessary to mitigate the risks of conducting deals in Africa, and doing a detailed due diligence often proves critical in giving investors more confidence. Consequently, African governments play a critical role in introducing reforms to create political, social and economic stability.
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